Majestic Research

Wall Street Journal

With adCenter, Microsoft Bids For Web-Search Bonanza

By Robert A. Guth and Kevin J. Delaney
Published: May 04, 2006

Microsoft Corp. today plans to show off the auction system it hopes to use to tap into the gusher of advertising dollars flowing online. The system, called adCenter, will be introduced at a conference the software maker is holding for hundreds of advertisers in Seattle. It’s Microsoft’s most ambitious effort yet to catch Google Inc., whose own system has been key to that company’s runaway revenue growth.

The auction services let advertisers bid against each other online to have their ads displayed alongside search results. Each time an Internet user searches for specific keywords, such as “digital camera,” the system displays a related ad for, say, a camera retailer. Advertisers pay if a consumer clicks on the ad, with prices per click averaging around 50 cents.

Companies spent $5.1 billion on search-related ads in the U.S. last year, up 31% from the year before, according to the Interactive Advertising Bureau trade group and PricewaterhouseCoopers LLP.

For Microsoft, adCenter is a critical part of a fundamental shift in strategy as the company tries to combine advertising with its traditional software business. AdCenter is “the next big revenue engine for the company,” says Tarek Najm, general manager of adCenter and Microsoft’s lead engineer on the project.

But it’s also a huge bet that demands a new set of skills that Microsoft is learning on the fly. First among Microsoft’s challenges: winning support among advertisers already devoted to Google’s system. Meanwhile, the competition is heating up: This month Yahoo Inc. will unveil long-awaited improvements to its auction system, and Google continues to improve and expand its approach.

For Microsoft, the advertising push isn’t just about growth. Over the past year, the company has come to realize what a risk the advertising model—which provides software and services free over the Internet, accompanied by ads—can pose to its traditional software business. Companies such as Google are offering the same types of programs—including word processors, calendars and email—for free that are major sources of Microsoft’s revenue and profits.

That’s one reason why in late 2004 Microsoft Chairman Bill Gates and Chief Executive Steve Ballmer gave a handful of engineers the go-ahead to build adCenter. Since then, the project has ballooned to several hundred engineers and researchers and comprises more than 500 large-server computers spread over two sites in Silicon Valley and at Microsoft’s Redmond, Wash., headquarters. AdCenter will initially be used for search advertising, but later extended to serve up other forms of ads, including possibly ads that appear in videogames and on TV sets, Microsoft executives say.

The system is a factor behind recent unrest among Microsoft shareholders, who were surprised last week when Microsoft said it needed to spend far more than expected—analysts estimate about $2 billion—next fiscal year on new development, including search and online services. Microsoft Senior Director Joe Doran says Microsoft’s efforts in online advertising are equivalent to building a whole new company. “I feel confident we are making the right investment decisions,” he says.

Microsoft has been running a trial of adCenter with about 6,000 selected advertisers. This week it opens the service to any advertisers that want to participate. In rolling out adCenter, Microsoft is phasing out its use of Yahoo’s service, which handled ad auctioning for Microsoft while the software giant built its system.

This month, Yahoo plans to start sharing details of improvements to its own search-advertising system. In 2003, the Sunnyvale, Calif., Internet company bought Overture Services Inc., which pioneered the current search-ad model during the 1990s. But over the past year, investors comparing earnings announcements noticed that Google’s edge over Yahoo in generating revenue from search was widening. Google brings in roughly 50% more revenue on average for each search query it handles globally than Yahoo, according to Majestic Research Corp. in New York.

In 2004, Google undertook a roughly 18-month project dubbed revenue force that significantly increased the amount of money it collected on average for each search. It did that partly by tweaking its formulas for choosing which ads to display for each query, and in what order. “We feel really comfortable not only in our current product but our future innovation cycles as well,” says Tim Armstrong, Google’s vice president for advertising sales.

Yahoo’s effort to improve its systems for advertisers and overall revenue per search has fallen behind the schedules it shared last year with some advertising companies and partners, officials at those companies say. The company hasn’t provided a specific calendar yet, but it has said it will roll out its new system during the second half of the year. The upgraded system will include changes in its formula for displaying search ads and more sophisticated tools to let advertisers target consumers in specific geographical locations, says a person familiar with the matter.

Among the big challenges now, particularly for Microsoft: getting more advertisers to use its systems, increasing search market share and syndicating ads, or recruiting other sites to display advertising purchased through the system.

Search advertising is a game of scale. The more places on the Web the ads are distributed, the more chances a consumer will click on them. The more that consumers click, the more advertisers the ad system attracts. The more advertisers the system attracts, the more they can wind up paying for each click as they bid against each other in an auction system. An internal document released by Google last year as part of a lawsuit indicated that the company had well over 400,000 advertisers.

Microsoft’s pitch yesterday and today features speeches by Messrs. Gates and Ballmer, a rare double billing that shows just how much is riding on the initiative’s success. The company has rented out Safeco Field, the ballpark where the Seattle Mariners play, for the finale tonight. So far, adCenter is getting high marks from advertisers who have tested it, partly because Microsoft has taken pains to court them and solicit their feedback.

Write to Robert A. Guth at rob.guth@wsj.com and Kevin J. Delaney at kevin.delaney@wsj.com